NCLT Can Reject a Scheme of Arrangement if it is not in Public Interest
October 2, 2019
In the case of Wiki Kids Limited, the NCLAT upheld the order of the NCLT rejecting a scheme of amalgamation, as it resulted in undue advantage to the promoters of the amalgamating company.
In the instant case, a non-listed company Wiki Kids Limited (Transferor Company), wished to amalgamate with Avantel Limited, a listed company (Transferee Company). For the aforesaid purpose, these entities (collectively referred to as Appellants) had proposed a scheme of amalgamation (Scheme) and approached the Andhra Pradesh High Court, seeking directions with respect to the meetings of the shareholders, and secured and unsecured creditors in the Scheme.
Pursuant to the directions of the High Court, the Scheme was approved by the shareholders of the Transferee Company. In the meantime, in view of a notification of the Ministry of Corporate Affairs dated December 7, 2016, the case was transferred to the National Company Law Tribunal (NCLT). The Appellants, accordingly, filed a second motion before the Hyderabad Bench of the NCLT. The NCLT, on perusal of various documents including the share exchange ratio and the valuation report, rejected the Scheme on the ground that it was beneficial to the common promoters of the Appellants and no public interest was being served.
Observations of the NCLT
The NCLT observed that the Transferor Company, even though incorporated in 2004, had not commenced its commercial operations. Further, the Transferor Company did not have any income except for some interest income from fixed deposits. The NCLT also noted that the Transferor Company had already spent ~INR 95 lakhs out of its paid up share capital of INR 117 lakhs and accordingly, its value was only ~INR 22 lakhs.
The NCLT further observed that the Audit Committee and the Amalgamation Committee of the Transferee Company, relying on the valuation of an independent chartered accountant and the fairness opinion of the merchant banker, approved a share exchange ratio of 100 equity shares in the Transferee Company of face value of INR 10 each for every 289 equity shares of INR 10, each fully paid up, held by the members of the Transferor Company. Thus, as per the exchange ratio the eligible number of shares to be issued by the Transferee Company to the shareholders of the Transferor Company worked out to approximately 4 lakh shares. The NCLT observed that accounting for the market value of the shares of the Transferee Company on June 30, 2017, the total value of the shares being issued to the shareholders of the Transferor Company worked out to be ~INR 12.4 crores.
The NCLT also noted that the Appellants had common promoters such that the promoters of the Transferee Company held 99.90% of the shareholding of the Transferor Company. Thus, the NCLT, in light of its analysis, held that the entire Scheme was designed in a manner to extend financial benefit of ~INR 12 crores only to the common promoters even though the Transferor Company had no business and little net worth/value. In view of such observations, the NCLT held the Scheme to be against the public interest and refused to approve the same.
Being aggrieved by the order of the NCLT, the Appellants approached the National Company Law Appellate Tribunal, New Delhi (NCLAT).
It was argued on behalf of the Appellants that all applicable requirements and directions were complied with and there were no objections to the Scheme from any concerned authorities like Bombay Stock Exchange Limited, Securities and Exchange Board of India, Registrar of Companies, Regional Director, Official Liquidator or Income Tax Department. It was also argued that the impugned order of NCLT was based merely on the numbers appearing in the balance sheet of the Transferor Company and failed to take into consideration the potential business model developed by it. It was asserted on behalf of the Appellants that the share exchange ratio had been computed by an expert independent chartered accountant in accordance with the settled principles of valuation and law, which includes the value of the potential business model in the market, including projected revenues and cash flows. Thus, there was no occasion to disbelieve the premises on which the share exchange ratio was arrived at.
The Appellants placed reliance on the decisions of M/s Miheer H. Mafatlal and M/s Hindustan Lever Employees’ Union and argued that the NCLT could not act as a court of appeal and sit in judgment over the informed view of the concerned parties to the Scheme, as the same would fall within the purview of commercial wisdom of the concerned parties. It was also contended that the role of NCLT was limited only to ensure that all stakeholders have been consulted in a proper manner and, hence, it acted beyond its jurisdiction by refusing to approve the Scheme.
The NCLAT pointed out the disclaimer in the valuation report issued by the independent chartered accountant, which stated that the entire valuation, provided in the report, was based on the documents provided by the management of the Appellants and the valuer had disclaimed the accuracy and reliability of such information. Thus, the NCLAT held that shareholders could not be said to have been conveyed sufficient assurance, merely by placing reliance on such a valuation report.
The NCLAT held that a scheme should be fair and in the interest of all shareholders and not only for a few among them. The NCLAT clarified further that the constitution of the NCLT comprises of both judicial and technical members. Thus, it has enough expertise to examine a scheme and to ensure that it is fair and just to all shareholders. The NCLAT agreed that it may not be desirable for the NCLT to look into mathematical details. However, if, from a broad review of the scheme, it appears to be unfairly beneficial to a particular class of persons, then it should exercise the expertise available to it and refuse to approve a scheme if, according to its opinion, it fails to uphold the public interest. In the context of the instant case, the NCLAT held that without going into deep mathematical details, it was apparent that the benefit to the accord of |INR 12 crores was flowing into the hands of the common promoters of the Appellants even though the net worth of the Transferor Company was only INR 22 lakhs. Accordingly, the NCLAT held that the Scheme was not beneficial to shareholders at large and upheld the decision of the NCLT.
Notably, the NCLAT distinguished the Supreme Court rulings in Hindustan Lever Employees’ Union (supra) and Miheer H Mafatlal (supra) on the basis of facts and rejected the reliance placed on them by the Appellants.
This is a very significant decision wherein the NCLAT has clarified that the NCLT is obligated to protect the public interest at large and may refuse to approve a scheme of arrangement, if the benefit of the impugned scheme is limited to only a certain class of persons and no public interest is being served. The NCLAT has further clarified that just because all the requirements / directions pertaining to a scheme (including approval of the shareholders and creditors) are complied with and no adverse observation has been made by any concerned regulatory authority, it would not mean that such a scheme shall be construed to be in general public interest. This ruling is of particular importance as far as decisions to restructure businesses are concerned, as the parties involved would have to ensure that any scheme of arrangement proposed under the Companies Act, 2013 has a rationale that the benefits of such a scheme ensues to all shareholders, and that the scheme is in public interest.
It is notable that courts, relying on the ruling of the SC in Miheer H Mafatlal (supra), have generally held that scope of judicial review in such matters is highly limited, and not appealable in nature. As long as there are no objections to a scheme and no fault or illegality have been pointed out, and relevant documents have been placed before concerned parties at the relevant time, courts have been held not to be in a position to interfere with schemes of arrangement. This is because such schemes are based on wishes of concerned shareholders, creditors, experts and professionals, apart from competent authorities, after scrutiny of the accounts and affairs of the companies. Accordingly, in absence of serious objection and prejudice to anybody, courts should not reassess the wisdom of the scheme. Specifically, it has also been observed that a scheme cannot be refused sanction merely because it results in benefits only to the promoter group, when such scheme enjoyed approval of a majority of shareholders.
In this regard, the NCLAT ruling appears to depart significantly from the existing judicial position, and expands the scope of review that the NCLT may exercise. Consequently, in the event of an appeal against this decision, the possibility of the final outcome being at variance from the NCLAT ruling, may not be denied.
 Wiki Kids Limited and another v. Regional Director and Other, Company Appeal (AT) No.285 of 2017
 M/s Miheer H. Mafatlal v. Mafatlal Industries Ltd, JT 1996 (8) 205 (SC)
 Hindustan Lever Employees’ Union v. Hindustan Lever Limited and Others, Special Leave Petition (civil) No. 11006 of 1994 (SC)
 J.K. Agri Genetics Ltd. v. Union of India (2012) 175 Com Cases 306 (Calcutta HC)